What is the long-term impact on China of the recent fall in shares value?

In today’s guest post Andrzej Bolesta, author of China and Post-Socialist Development, provides his insight into why the current situation will have minimal long-term impact on China.

Dr Andrzej Bolesta

Recently the media have been writing a lot about China’s stock exchange. They have been speculating about the reasons for the fall in shares value and about the possible long term trends impacting China’s development trajectory.

Between the middle of June and the end of August, Shanghai’s stock exchange composite Index fell by around 40 percent, whereas Shenzhen’s by around 45 percent. Although for many investors and analysts it is important to see short term causes and consequences of the current “correction”, for researchers like myself, the paramount issue is whether the current situation is part of a larger package of occurrences, which might impact China and thus the world.

Limited long-term impact

My opinion is that the current situation will have a minimal long‐term impact on China, if any. China’s other challenges are way bigger than the recent troubles related to the stock market.

Firstly, bear in mind that the indexes are still higher than when the boom started last year. This boom is difficult to associate with robust economic growth, as the “new normal” pace is not a double digit figure. Consequently, it is also difficult to associate the current correction with some specific troubles of the Chinese economy.

“there are many things about the companies listed on the stock market that we don’t know…”

Naturally, there are all sorts of factors which are believed to have contributed to the current state of affairs; for example, the financial supervisory authorities have manipulated the regulations concerning the availability of credit to purchase shares, the August devaluation of the RMB has been perceived as an illustration of another weakness of the Chinese economy, speculations that the US Federal Reserve will increase interest rates initiated the flight of the dollar back to America.

Secondly, and perhaps more importantly, there are many things about the companies listed on the stock market that we don’t know. Many of them are state‐owned enterprises with
only limited share available for trading and China’s economy is not the most transparent one.

Consequently, these companies’ standing often depends on non‐market, political factors. Hence, investors have a limited knowledge upon which to act. This contributes to the level of uncertainty, which, in turn, may perhaps generate fluctuations and these fluctuations can be perceived as irrational.

Active macroeconomic policy

Thirdly, to try to amend economic problems, China still has room for active macroeconomic policy. Unlike the US and Europe, it can comfortably continue lowering its interest rates. Moreover, its central government’s debt is comparably low.

Fourthly, the impact of the current situation on the Chinese citizens, as broadly argued, will be rather insignificant. The stock market capitalization as compared to the national GDP is lower than in advanced economies and thus their influence on the national economy is limited. Moreover, the shares are significantly dispersed among many small scale private
investors.

“So whatever happens in China does not stay in China”

Nevertheless, make no mistake. Whatever happens in China has most likely either short term or long term, or both, consequences for the rest of the world.

Soon to be the biggest economy in the world (according to purchasing power parity estimates it already is), China is an integral and deeply integrated component of the global economy. Shanghai is becoming one of the capitals of the financial world.

So whatever happens in China does not stay in China. Consequently, many stock markets around the world have followed suit and recorded falling indexes. However, what may worry the rest of the world the most is China’s slowing rate of economic growth, inevitably perceived to become a long term trend. The slow down affects primarily China’s suppliers of raw materials and energy resources, then the economies with a large share of export directed to China, for example, as part of the regional production chains, and then everybody else.

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